VOT Research Desk
The Federal Reserve’s recent dovish turn may continue to weigh on the US Dollar, according to economists at Brown Brothers Harriman & Co. (BBH), despite the fact that the underlying environment remains bullish.
Although DXY is trading close to 105.15, it has managed to hold onto much of yesterday’s gains. Despite our continued support for the underlying view favoring the dollar, we accept that due to Powell’s unexpected dovish move, near-term dollar depreciation is likely to persist.
That dovish Fed narrative may begin to crumble if U.S. data remain solid, especially ISM services. Following Powell’s address last week, the tone of the story shifted to one of doves.
The tone of that narrative is returning to hawkish after AHE and services PMI. We anticipate some rumors on 75 bp from the Fed next. however, we believe that it will largely depend on the CPI statistics released the day before the decision.
Having said that, we believe Powell erred when he removed 75 bp from the table last week. A 50 bp increase on December 14 is still predicted by WIRP to be fully priced in, with only 5% odds favoring a greater 75 bp shift.
A peak policy rate of 5.0% is what the swaps market is pricing in, but odds of a higher peak of 5.25% have resurfaced. Despite declining CPI and PPI readings, both AHE and core PCE have been stable at or near 5% for the majority of this year.
We think it will be harder to get core PCE back down to the Fed’s objective of 2% than markets are factoring this in. Given how firm the labor market is still and how well the economy is doing, we don’t believe two additional 50 bp rate increases will be enough.
